Whistleblower Alleges Widespread Manipulation of Mortgage Funds

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Industry veteran John Flynn claims he has found “$150 billion in inflated CMBS issued between 2013 and today.”

ProPublica reports that “according to a previously unreported whistleblower complaint submitted to the Securities and Exchange Commission last year,” there is “evidence something similar” to the inflated mortgages with dodgy numbers of the 2008 financial crisis is appearing again in commercial real estate.

  • John Flynn, an industry veteran, submitted a whistleblower complaint to the United States Securities and Exchange Commission in 2019 alleging that he had gathered “materials identifying about $150 billion in inflated [commercial mortgage-backed securities] issued between 2013 and today.”
  • ProPublica states that they “closely examined six loans that were part of [commercial mortgage-backed securities] in recent years to see if their data resembles the pattern described… What [they] found matched the allegations.”
  • Broadly, the allegation is that numerous commercial mortgage-backed securities, a type of bond sold to investors, are based on commercial mortgage loans with inflated numbers.
  • This inflation enables borrowers to qualify for larger loans—though they arguably may be unqualified to pay them back—and also leads to larger fees for banks.
  • In the 2008 financial crisis, similar bonds and investment pools from residential properties led to widespread defaults, “damaging homeowners and investors alike.”

ProPublica explains,

As a rough analogy, imagine a homeowner having stated in a mortgage application that his 2017 income was $100,000 only to claim during a later refinancing that his 2017 income was $130,000—without acknowledging or explaining the change.

According to Flynn’s complaint, some of these widespread efforts to make adjustments involved simply removing expenses from applicants’ ledgers, artificially increasing their profits for a given year. This was the case for each loan ProPublica closely examined.

For example, a 2015 loan from Ladder Capital to a group that purchased the Doubletree San Diego hotel increased the hotel’s main loan by 60%, and its operating income for 2013 and 2014 had “magically jumped from what had previously been reported.”

When asked about this discrepancy, Ladder Capital explained,

it altered the expense numbers it provided in the Doubletree’s historical financials. Ladder said it wiped lease payments—$700,608 and $592,823 in those two years—from the historical financials, because the new owner would not make lease payments in the future. (The previous owner had leased the building from an affiliated company.)

The Doubletree eventually struggled under its new arrangement, and Ladder foreclosed in 2019.

As ProPublica explains, “Some lenders interviewed for this article maintain they’re permitted to alter properties’ historical profits under some circumstances.” Based on the cases that ProPublica examined, some lenders may be considering one-time expenses or expenses that were no longer ongoing as appropriate circumstances.

Although Ladder Capital spoke to ProPublica, Wells Fargo and Deutsche Bank—who are also mentioned in Flynn’s complaint—declined to comment.

And ProPublica adds, “The SEC, which has not taken public action on the whistleblower complaint, declined to comment.

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